10/24/2005 @ 9:00AM

Commercial Conversations

Markets, as the saying goes, are conversations. Theyre not always conversations we know were a part of, but theyre going on all the time, as buyers and sellers (potential and real) are in perennial communication. Sometimes–such as when a company assembles a market research group, or when a frustrated customer asks to speak with a manager–we communicate with words. But most of the time, the conversation takes a different form, and commerce itself–advertising, browsing, sales and purchases–becomes the way customers and businesses talk to each other.

In one sense, this is obvious. If you buy something, after all, youre not just acquiring it. Youre also sending a message to the seller that you like this product or service, and that usually means that the company will deliver more of it in the future. And if you walk out without buying anything–or, even worse, if you return something after youve already bought it–that sends the exact opposite message. Companies, meanwhile, are constantly bombarding their customers and would-be customers with information, both implicit (offering a product for sale is a kind of promise about its value) and explicit (television advertising, for example). But things start to get complicated when you bring the possibility of deception into the mix.

In any conversation, after all, you have to make a decision about whether the other person is telling the truth. Deception is always possible, and its obviously more likely if one side has a lot to gain from fibbing. So customers, in particular, are always forced to figure out whether or not the messages companies are sending out are accurate or not. Historically, this has not always been an easy thing to do, because in general, companies have a lot more information about the stuff they make than customers do. Especially when it comes to what economists call experience goods–which are the types of goods, including everything from movies to food, that are hard to evaluate without using them–customers are at a serious informational disadvantage. And that makes customers cautious and skeptical, which makes it hard for businesses to reach them.

The classic example of this is the used-car market. As the economist George Akerlof first pointed out, if youre thinking about buying a used car, you dont have any easy way of telling whether or not the car is a lemon. A test drive obviously cant tell if the car is going to break down three weeks from now, and the dealer is unlikely to come clean. So in the absence of other information, anyone thinking about buying a used car has to factor in the possibility that its going to break down, which obviously lowers the price youre willing to pay. And it lowers the price for all cars, not just lemons, because the whole point is that you dont know which cars are reliable and which arent. The problem is that people who know they have good cars wont want to sell them at that lower price, so theyll start dropping out of the market. That means that more and more of the cars left will be lemons, so customers will drop the price theyre willing to pay even further. This, in turn, forces more sellers out of the market, until eventually there will be no reliable used cars left. In other words, because its impossible to tell whos telling the truth and who isnt, the whole market collapses.

Now, in reality, there are a variety of ways we can use to get around this: personal references, brand names and so on. But one of the most interesting ways is for businesses to, in effect, use commerce to convey more information, in a process the economist Michael Spence calls signaling. Again, consider the used-car example. The honest dealer can distinguish himself from the ones purveying lemons in a simple way: He can offer a warranty. Dealers selling lemons cant do this, because they know if they do theyll be stuck with heavy repair costs. So simply offering a warranty communicates that the product is reliable. The same is true of companies such as L.L. Bean, which will let you return a product for any reason no matter how long ago you bought it. On the one hand, of course, theyre just making you feel secure (even if you wont bother returning that worn-out pair of shoes, it makes you feel better to know you could). But the deeper message, even if its one we dont necessarily process consciously, is that their products are so reliable that they can make this offer without worrying about how much itll cost. Youd only make that promise, after all, if you were confident that you wouldnt have to keep it very often.

Signaling also helps explain why companies spend so much on advertising. It isnt just about increasing customer awareness of a product. Its also a way of communicating their faith in the product. You wouldnt pay tens of millions of dollars to promote a dog, or so the thinking goes, so the product must be good. Advertising does raise the possibility of the self-fulfilling prophecy: If you spend enough on ads for a bad product, maybe you can effectively trick enough people into buying it to make a dog profitable. If this is possible, then advertisings signaling value would disappear. But in fact theres little evidence that advertising can turn a useless product into a popular one. In the long run, products succeed via quality and word of mouth. So a company that spends a lot to promote a product probably is signaling that it thinks the chances of success are good.

In all these cases, then, commerce is functioning as communication. But the thing to notice is that this conversation is really more of a monologue: companies talking at customers. And the only way most customers have spoken back is by making the decision to buy or not. The economist Albert O. Hirschman famously distinguished between two ways people can register disapproval: exit (that is, you leave, or in this case, you just dont buy something) or voice (you explain exactly whats wrong and what youd like instead). Markets have historically relied mostly on exit: Customers make their wishes known with their dollars. This is a crude kind of communication, but it does work surprisingly well–businesses actually do adjust to what customers want. Its startling, in fact, to realize how much communication is contained in a simple decision not to buy.

At the same time, exit leaves a lot of information out, which is to say that theres just a lot about what customers want and dont want that companies never discover. Its been this way in part because of practical considerations–its been technically difficult to aggregate detailed information from customers. But its also been this way in part because most companies have had a top-down mindset, predicated on the idea that, ultimately, companies know best and customers need to be told what they want. To be sure, firms have always engaged in market research and so on. But this has traditionally been more about figuring out how to get customers to buy what businesses want to make rather than helping businesses make what customers want to buy.

Now, though, everything is up in the air. The tools to change communication from a monologue to a dialogue are already with us, most obviously on the Internet, where customers are already having very loud conversations with each other on sites such as
Amazon.com
and ePinions and throughout the blogosphere. More strikingly, there are now markets, such as the Hollywood Stock Exchange (where people can buy and sell play-money shares based on how they think movies will do at the box office), where customers are producing collective–and remarkably accurate–judgments about the future of products. As a result, commerce is going to increasingly shift away from older forms of communication–signaling and advertising will be both less necessary and less effective because consumers can now get good information from so many sources–toward something that resembles a real conversation. In effect, voice will replace exit. Some steps are already being taken in this direction, with some companies tapping these prediction markets for insight into what customers want and others actually opening up their design processes to their customers. But there is a long way to go. In the end, for commerce to really communicate, information needs to flow in both directions. Companies are very good at talking. Now they need to start listening.